The Different Kinds of Business Costs
Business cost distinctions help you better appreciate the cost figures for the things that your business produces or sells. Correct product costs (for businesses that sell products, of course) are extremely important.
Direct versus indirect costs: Direct costs are easy to match with a process or product, whereas indirect costs are more distant and have to be allocated to a process or product.
Fixed versus variable costs: If your business sells more units of a certain item, some of your costs increase accordingly (variable costs), but others don’t budge one bit (fixed costs).
Relevant versus irrelevant costs: Not every cost is important to every decision you need to make about your business. Hence the distinction between relevant and irrelevant costs:
Relevant costs: Costs that should be considered and included in your analysis when deciding on a future course of action. Relevant costs are future costs — costs that you would incur, or bring upon yourself, depending on which course of action you take.
For example, say that you want to increase the number of books that your publishing business produces next year in order to increase your sales revenue, but the cost of paper has just shot up. That cost will affect your bottom-line profit and may negate any increase in sales volume that you experience (unless you increase the sales price). The cost of paper is a relevant cost.
Irrelevant costs: Costs that you should disregard when deciding on a future course of action; if brought into the analysis, these costs could cause you to make the wrong decision. An irrelevant cost is a vestige of the past — that money is gone.
For example, suppose that your supervisor tells you to expect a slew of new hires next week. All your staff members use computers now, but you have a bunch of typewriters gathering dust in the supply room. Should you consider the cost paid for those typewriters in your decision to buy computers for all the new hires? Absolutely not — that cost should have been written off and is no match for the cost you’d pay in productivity (and morale) for new employees who are forced to use typewriters.
Actual, budgeted, and standard costs: The actual costs your business incurs may differ (though hopefully not significantly) from its budgeted and standard costs:
Actual costs: Historical costs, based on actual transactions and operations for the period just ended, or going back to earlier periods.
Budgeted costs: Future costs, for transactions and operations expected to take place over the coming period, based on forecasts and established goals.
Standard costs: Costs, primarily in the area of manufacturing, that are carefully engineered based on detailed analysis of operations and forecast costs for each component or step in an operation.
Product versus period costs: Some costs are linked to particular products, and other costs (not linked to products) are recorded as expenses immediately, without passing through the inventory account.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
